Why Is Citigroup Inc. (C) Hedge Funds’ Favorite Bank?

Citigroup Inc. (NYSE:C) isn’t the most popular financial stock among hedge funds anymore- heavy buying activity at AIG gave that company the #1 slot (see more of hedge funds’ favorite financial stocks)- but our database of 13F filings still showed more hedge funds and other notable investors owning it than any of the other big banks. Billionaire David Tepper’s Appaloosa Management, a fund with $16 billion under management, had Citigroup Inc. as its second largest stock holding at the end of September according to its 13F filing (find more of billionaire David Tepper’s stock picks). Citadel Investment Group, which is managed by billionaire Ken Griffin, more than tripled its own position in the stock during the third quarter to a total of 4.1 million shares (check out more stocks that Citadel was buying).

David Tepper

In pure value terms, this makes some sense. Citi’s P/B ratio is only 0.6, so the stock is trading at a large discount to the book value of its equity. Wall Street analyst expectations have the stock trading at 8 times next year’s earnings, which would certainly make a company a candidate for value status, and the five-year PEG ratio is 0.7 as Citi is expected to grow its earnings further in the next several years.

However, Citi’s recent business performance has not been particularly good. In the third quarter, its net interest revenue declined slightly compared to a year ago and non-interest revenue dropped 77%. With expenses not showing much of a decrease, the bank reported an operating loss and only had positive earnings because of income tax benefits. For the first nine months of the year, Citigroup Inc. experienced a 15% decline in revenues versus the same period in 2011 and recorded $2.06 in earnings per share. That annualizes to a less generous P/E multiple of 13- and was down 38%. So baked into analyst expectations is the presumption that Citi will do much better in 2013.

Some other big banks aren’t relying on an improvement next year, and any broader industry trends which benefit Citi should help them as well. JPMorgan Chase & Co. (NYSE:JPM), for example, trades at 9 times trailing earnings and 8 times forward earnings estimates. On that basis, then, it’s about even with Citi in terms of valuation even though the bank has been growing its revenue and earnings, and is generally viewed as a safer bank despite its London Whale losses. Its P/B is a bit higher than Citi’s at 0.8, but that’s still a considerable discount to book value and we’d consider it a better investment. A very similar story holds for Wells Fargo & Company (NYSE:WFC): with its stock lagging Citi’s, Wells Fargo’s forward P/E is now only 9. That’s a very slim premium for what is generally considered a better bank. Wells Fargo does post a P/B of 1.2, so it’s a bit harder to make a value case on a book basis, but it’s at least worth considering that Wells Fargo does seem to be doing a better job than Citi at making money off of its assets.

We can also compare Citi to Bank of America Corp (NYSE:BAC) and HSBC Holdings plc (NYSE:HBC). Bank of America has a slightly lower P/B ratio than even Citi, but its earnings have been down even more and the stock’s price actually has it as the most expensive of these banks in terms of forward P/Es. We think it’s best to avoid it. HSBC had its earnings about cut in half in its most recent quarter compared to the same period in the previous year, and its forward P/E matches Citi’s at 8; however, this bank trades at a premium to the book value of its equity, so we’re not persuaded that it’s a better buy.

Still, JPMorgan Chase and Wells Fargo look like better investments than Citigroup. JPMorgan Chase is about even in terms of multiples, but has been reporting better earnings numbers; Wells Fargo is a bit more expensive, but has a reputation as a safer bank as well as stronger performance. Each of these banks makes our list of hedge funds’ favorite financial stocks, and they are more attractive to us than the more popular Citi.

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